Institute of Certified Management Accountants of Sri Lanka

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1 Copyright Reserved Serial No Managerial Level Pilot Paper Instructions to Candidates 1. Time allowed is three (3) hours (with an additional reading time of 15 minutes). 2. Answer all questions in Part I and any three (3) questions from Part II. 3. The answers should be given in the English Language. Subject Subject Code Integrative Management Accounting (IMA / ML 1) PART I Question No. 01 (40 Marks) Apple is a division of Fruits Plc. It is now in the process of introducing a new product to the market utilizing one of the factories that is not currently used for any production purpose. In this respect, a market research has already been carried out at a cost of 400,000/-. The market research reveals that the new product XX will last for four years. A new plant at a cost of 3.75 mn will have to be purchased for the production of XX. The technical specifications of the plant indicate that a major overhaul at the end of the second year is needed to maintain the production capacity at the expected level. The overhaul cost may vary between 500,000/- to 1 mn, to depending on the operating condition of the plant at the end of year two. It is expected there is 75% probability that the plant is in good condition, in which case the overhaul cost will be 500,000/-. If the plant is in bad condition, the overhaul cost will go up to 1 mn. Further, the plant will qualify to receive 25% tax depreciation. It is estimated that the scrap sales value of the plant will be 1 mn at the end of the life of the project. According to the market research, XX can be sold at 1,200/- per unit in the first year. Estimates of product demand depend on different economic conditions. Three economic conditions have been identified as follows: Economic condition Probability of occurrence Demand in the first year (units) Good ,000 Moderate ,000 Bad ,000 Demand in subsequent years is expected to increase at 20% per annum, regardless of the initial level demanded. As the product XX will be a novel product in the market, the company does not foresee competitors in the first year. However, the competitors may enter the market from the second year onwards. This may compel Apple to reduce the price of XX. Due to the uncertainty surrounding this issue, the Board of Directors believes the selling price of 1,200/- per unit should not be adjusted. 1

2 The unit variable cost and fixed overhead costs (excluding depreciation) are expected to be as follows during the first year of operations. Variable production cost per unit 800 Variable selling and distribution cost per unit 125 Fixed production cost for the year 3,000,000 Fixed administration, selling and distribution cost for the year 1,200,000 The following rates of annual inflation are expected for each of the years (year two to year four): % Selling prices 6 Production costs 7 Administration, selling and distribution costs 5 However, another company has now requested to obtain the factory at an annual rent amount of 200,000 for the next three years. The rent income is expected to rise by 10% annually. It is expected that this opportunity will be lost entirely, if the factory is not rented now. Working capital requirements would be 1 mn in the first year, rising to 1.5 mn in the second year and remaining at this level until the end of the project, when it will all be recovered. The company pays taxation on its profits at the rate of 30% which is paid in the following year. The Board of Directors of Fruits Plc has agreed to use a 12% post-tax discount rate to evaluate this investment as it has been the rate used to evaluate other projects in the group. The board also agreed to appoint Mr. Perera as the officer in-charge of this project. (a) Determine the viability of introducing product XX. (15 Marks) (d) Calculate the sensitivity of the selling price and explain its significance to Apple. (05 Marks) What are the strategies you can take to reduce the sensitivity of the Selling Price? Discuss your answer. Discuss whether the expected value method is an appropriate way of evaluating the different risks inherent in the new product decision of Apple. Now assume you have reached the end of the project and the Board of Directors of Fruits Plc is planning to carry out a post completion audit. However, Mr. Perera is of the view that post completion audit is, in fact, backward-looking technique as it cannot reverse the decision to incur the capital expenditure of 3.75 million. Thus, he is of the view that it does have a no control value. He also believes that certain crucial factors, such as the amount of capital expenditure, selling price of XX, suppliers selected for raw materials were outside his control and he is not responsible for decisions regarding those factors. (e) Evaluate the use of post completion audit for this project. (08 Marks) (Total 40 Marks) End of Part I 2

3 PART II Answer any 3 questions Question No. 02 (20 Marks) ALBA Ltd is a company that manufactures various electronic equipments. Its consumer electronic division makes two products, ProdA and ProdB. This division has always been the flagship division of ALBA Ltd generating much of the profit of the company. However, the management of the consumer electronic division has realized that due to the stiff competition in the consumer electronic market, the demand for its two products has come down. After carrying out a market research it has identified the maximum monthly sales demand for ProdA and ProdB will be 900 units and 800 units respectively. The estimated information of these two products is given below: ProdA ProdB Direct materials per unit 2 kg 1 kg Direct labour 2 hours 0.5 hours Selling price per unit () 7,500 5,000 The cost of direct materials is 1,000/- per kg. All the employees are paid at 1,000/- per hour. Currently ALBA Ltd does not foresee any resource constraint with respect to direct materials and labour. A sales commission of 20% on the selling price is paid for the sales staff. The two products use the machine time in Assembly Department and Finishing Department which is limited to 3,500 hours and 5,000 hours respectively per month. The number of hours required for each of these products in these departments is as follows. ProdA ProdB Assembly Department 2 hours 4 hours Finishing Department 5 hours 4 hours The fixed costs of operating these departments are 850,000/- per month. However, the management of the division is uncertain as to the combination of the product mix that will maximize the profit of the division under these constraints. (a) Advise the management of the consumer electronic division on the optimum production plan, using a graphical linear programming model. Calculate the maximum profit that could be earned by the division. (12 Marks) The division is now planning to hire additional equipment for the Assembly and Finishing Departments in a bid to increase the production. An equipment supplier has quoted 500 and 225 per hour respectively for the equipments for the Assembly and Finishing Departments. Advise the management of the consumer electronic division whether they should hire the additional equipments from the supplier to increase the production. (08 Marks) 3

4 Question No. 03 (20 Marks) Atlus Holdings is a large conglomerate which has business interests in many different sectors in Asia. These sectors face different operating conditions in terms of competition, customers, regulations, suppliers etc. The sectors are given full autonomy with regard to operational decision making and the top level management primarily involves in decisions which have far reaching consequences on the sectors. The managerial performance in these various sectors is evaluated on the achievement of a predetermined profit. The Manufacturing Sector, the largest sector of the conglomerate, has two companies Blak and Deck. Blak produces only one type of component BX, which it transfers to Deck and also is sold in the external market. Deck uses this component in its final product DX and Blak is the sole supplier of the component, at present. Deck is under pressure to reduce the cost of DX due to the stiff competition it faces in the market. Deck has been approached by an external supplier who produces a component similar to BX called XX. The external supplier has offered to supply 5,000 components of XX annually at 70 each. The following estimates of Blak are available for Sales revenue: Sales to 80 Per unit 8,000,000 External 90 per unit 5,400,000 Less: Variable 44 per unit 7,040,000 Fixed costs 2,000,000 Profit 4,360,000 Note: The above activity level represents the normal activity level for Blak. The following details for Deck are available for 2010 (before accounting for the costs of internal transfers). Sales ,000,000 Less: Variable 21 per unit 2,100,000 Fixed costs 3,000,000 Profit 11,900,000 (a) (d) Describe the factors that drive decentralization of decision making in a company such as Atlus Holdings. Prepare profit statements for Blak and Deck for the following situations: (i) If internal transfers are valued at full costs. (ii) If internal transfers are valued as two-part-tariff system where the annual fixed fee is 100,000/-. (iii) If a dual pricing system is used. (iv) If Deck decides to buy from the external supplier. Discuss the potential dysfunctional issues that may arise owing to the present structure of the group with reference to your answer for part b. Recommend suitable remedial actions in order to overcome the problems you have identified. 4

5 Question No. 04 (20 Marks) Chemika Ltd. is a large specialty chemical company, with sales of 72 billion, operating in many global consumer markets. The annual budgeting process, it used previously, took more than six months for preparation. Further, it slowed down Chemika s ability to respond to the changing requirements in the market. The management of the company also noticed that the prices and margins are under pressure due to heavy competition from the low cost chemical producers from Far East. The analysis of marketing department further indicated the customers are now increasingly switching to low cost suppliers. In 2011, in a bid to overcome these challenges, the company replaced its budgeting process with two performance management cycles. One cycle takes a long term view and continually looks two to five years ahead, with an annual review of its performance. The other cycle takes a medium term view and looks five to eight quarters ahead, with a quarterly performance review. (a) Describe the two major budgeting approaches followed by Chemika Ltd before and after Discuss the negative consequences of budgeting that could have arisen before Evaluate how the principles of new budgeting system would facilitate Chemika Ltd to overcome the weaknesses mentioned in part. (10 Marks) Question No. 05 (20 Marks) Cane Craft Ltd. is an established manufacturer which produces cane products for hotels and luxury apartments. The company purchases raw materials (canes) for the production from wholesale dealers in Wewaldeniya area. Currently the company is facing stiff competition due to attractive high quality imports of cane products. In this context, the company has recognized the need to produce good quality cane products for its customers. However, it does not have a formalized quality management program in place. A director of the company has recently returned from a workshop, where the theme had been the concept and implementation of Total Quality Management (TQM). He stressed at a meeting with the staff that the company must meet or exceed customer expectations to face the rising competition. (a) Describe the key principles of Total Quality Management (TQM). (05 Marks) As stated by the director, discuss why a customer focus is a critical element of TQM for Cane Craft Ltd. (05 Marks) As a student of Management Accounting, discuss the importance of TQM for Cane Craft Ltd and how it may be introduced into different areas of the company s operations. (10 Marks) End of Part II End of Question Paper 5